For the second year running, India has dramatically improved its ranking in the World Bank’s doing business index (DBI) – from 130 in 2016 to 77 in 2018 – and is gaining on China (ranking 46) and Russia (ranking 31). While this improvement is worth celebrating, how it is impacting India’s economy is a poorly studied area and needs urgent attention.
But before that, a caveat is in order.
DBI is based on 10 parameters that measure “business regulation” – like starting a business, construction permits, getting credit etc. (It also measured labour market regulation separately but did not consider it for the ranking.)
What it does not cover are: “macroeconomic stability, development of the financial system, quality of labour force, incidence of bribery and corruption, market size and lack of security”. Thus, DBI is only one of the indicators of economic perspectives of a country.
India has been seeking to improve its DBI ranking primarily to attract foreign direct investments (FDI) and make ‘Make in India’ a success. The World Bank too promotes the concept that better business regulations (that is better DBI ranking) are associated with higher FDI inflows. Interestingly, India has witnessed a dramatic and steady rise in FDI inflows since 2014 – from $36 billion in 2013-14 to $45.15 billion in 2014-15, $55.56 billion in 2015-16, $60.22 billion in 2016-17 and $61.96 billion in 2017-18.
But the critical question is: Has higher FDI inflows led to higher GDP growth, higher capital formation (investment) or higher industrial output and capacity utilisation (relevant to ‘Make in India’ programme)? The answers are a clear ‘No’. And thereby hangs a tale.
The growth rate of GDP has been falling since 2015-16. According to the Economic Survey of 2017-18, the growth rate (at constant price and base year of 2011-12) was 7.5 percent in 2014-15, which went up to 8 percent in 2015-16 and then declined to 7.1 percent in 2016-17 and 6.5 percent in 2017-18.
Gross fixed capital formation (GFCF), which is an indicator of investment in the economy, has also been going down steadily – from 34.31 percent of GDP in 2011-12 to 28.5 percent in 2017-18 (at current price).
The Index of industrial production (IIP) growth remains low and fluctuating. The growth rate in eight core sectors (coal, crude oil, steel, cement etc.) went down from 4.9 percent in 2014-15 to 3 percent in 2015-16, went up to 4.8 percent in 2016-17 and fell to 4.2 percent in 2017-18. Capacity utilisation of manufacturing companies has been fluctuating since 2014-15 and the first quarter of 2018-19 witnessed a sharp decline.
One is tempted to ask: Why is FDI going up when the relevant macroeconomic indicators are going down? What exactly is FDI doing to the Indian economy?
First, World Bank says that though worldwide studies have shown that better business regulation (reflected in DBI ranking) is “associated with higher levels of FDI”, yet this association “does not imply causation” and that there is no evidence of such association for ‘developing countries’.
A 2016 IIM Bangalore working paper says that DBI ranking has “limited macroeconomic usefulness and relevance”, explaining that this ranking is a de jure measure that does not capture the de facto practices that are used to get around the law to get business done: personal connections, jugaad solutions. Besides, it says there is a distinction between the ease of doing business and the cost of doing business and that in large unorganised economies (like India), the cost of business is low (since much activity escapes tax net) even if starting a business is difficult and DBI rank is low.
This disconnect is captured in Ruchir Sharma’s 2016 book The Rise and Fall of Nations: Ten Rules of Change in the Post-crisis World. It talks of Vladimir Putin improving Russia’s ranking from 120 to 51 between 2012 and 2015 – more than 30 places ahead of China and 60 places ahead of Brazil and India – and yet nobody was doing business with Moscow. Why? He explained: “Moscow in 2015 is increasingly hostile to and isolated from international business, far more so than China, Brazil or India. To the extent possible, I try to avoid relying on numbers that are vulnerable to political manipulation and marketing.”
In India, it is a matter of study as to why higher FDI inflow has not led to higher growth indicators. Prof R Nagaraj of Indira Gandhi Institute of Development Research has one explanation. In his 2017 paper Is FDI the New Engine of Growth?, he writes that this is because, “Currently FDI does not come from leading global producers of goods and services, but from shadow banking entities such as private equity (PE) funds”. He says in 2014-15, PE accounted for 60 percent of total foreign inflows and the top recipients (Flipkart, Paytm and Snapdeal) were retail trade of mostly imported consumer goods. PE firms do not commit to fresh capital formation or invest in technology as expected, he adds.
‘Round-tripping’ – channelling local funds abroad, which subsequently return to the local economy in the form of direct investment – is another issue that needs probing. Mauritius has emerged as the top FDI source for India by contributing a maximum of 33 percent of inflow (the second being Singapore with 19 percent) since 2016-17. Here is what Exim Bank’s 2014 working paper Outward Direct Investment from India: Trends, Objectives and Policy Perspectives says on round-tripping: “Round-tripping can take many formats like under-invoicing and over-invoicing of exports and imports. Round-tripping involves getting the money out of India to, say, Mauritius, and then bringing it back to India as FDI or FII investment. Round-tripping is a major reason for Mauritius being a source as well as destination for FDI.”
Amitabh Kant, CEO of Niti Aayog, was right when he said last year (soon after India’s DBI ranking was announced to be 100) that India’s next goal was to improve domestic investment – which has hit a new low. India is facing twin-balance sheet (TBS) challenge, as former CEA Arvind Subramanian kept reminding – over-indebtedness in the corporate sector, depressing demand for investment and growing NPAs reducing supply of credit.
Around the same time last year, CMIE had said in its October 2017 report that India had registered “the lowest level of intention to invest seen in any quarter during the tenure of the Modi government” in the quarter ending September 2017 – even lower than June 2014 quarter “when investments had come to a halt for all practical purposes in the face of political uncertainty”.
In its October 2018 report, it says new investment proposals in the quarter ending September 2018 “belie hope” of a revival in investment sentiment and “fail to live up to the small promise held out during the past few months.”
Therefore, it may be more useful for India to focus on strategies to revive investment and ask a few relevant questions regarding the FDI inflow.
Updated Date: Nov 01, 2018 15:07 PM